Canada Life Asset Management’s Steve Matthews expects the Bank of England to raise its Base Rate by 25bps to 5.50% on Thursday.
“The Bank of England (BoE) appears to be approaching a crossroads. July’s disappointing decline in GDP of 0.5% may well herald the biting point of a painful series of 14 successive rate hikes and could signal the need for a pause in the cycle.
“However, whilst certainfood and household energy prices may be coming down and relieving some pressure, the BoE still has the pressing issue of stubborn wage-fuelled core inflation to address and, for this reason, we see one further hike of 25bps to not only target a further reduction in inflation but to bring it under control over the longer term.
“Markets have come down a long way from their peak hike expectations and are now seeing Thursday’s decision as the end of the cycle. On balance we agree with this and see one last hike of 25bps to a peak of 5.50%, with future movements to be data-driven.”
James Lynch, fixed income investment manager at Aegon Asset Management also believes that the BoE may hike again on Thursday but, in his view if they do then it’s only for show – as rates are already reining in the economy as he comments:
“With interest rates at 5.25% and now openly acknowledged as being in restrictive territory by MPC members, we are at the point where the next policy rate decision will be a hike or a pause.
“The debate on the MPC will centre around mixed incoming data. Lagging data will tell them to hike, as wages and inflation are still at too high a level, and neither are consistent with the BoE remit of 2% inflation. However, real time data on the economy will be telling them a different story.
“The labour market is loosening, with vacancy rates dropping and jobs being shed. Even with wage rises at a high level, the acceleration has started to reverse. The activity data is poor, with the last reading of GDP showing a monthly fall of -0.5% and the PMI readings below 50, showing contraction readings. Meanwhile, the housing market has moved from hot to cold, as prices fall and demand falters from the combination of mortgage payment increases and a sluggish economy.
“All these economic indicators are going to worsen regardless of whether the BoE hikes on Thursday or not, as the lagged impact of the previous increases in interest rates takes effect. So what good will another 25bps increase do? Not much. The previous 515bps increase is doing the work. But for the BoE it is once again a confidence and communication issue. Not raising rates with the high level of wages and inflation will be a difficult message for them to sell.
“The BoE also has to make a decision on the size of its balance sheet. After the last year of reductions, gilt and corporate holdings are around £759bn, down from £895bn. The number of gilts redeeming over the next year increases to £50bn. On top of that, we would expect them to keep the pace of sales the same, meaning a reduction of circa £90bn to £100bn of gilts in total. Given that the BoE think this is not having an effect on the level of rates, and therefore monetary policy transmissions purposes, the main reason to reduce is so it can utilise QE again in the future.”
